REPORT TO CONGRESS Macroeconomic and - …

REPORT TO CONGRESS

Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States

U.S. DEPARTMENT OF THE TREASURY OFFICE OF INTERNATIONAL AFFAIRS April 2018

Contents

EXECUTIVE SUMMARY ......................................................................................................................... 1 SECTION 1: GLOBAL ECONOMIC AND EXTERNAL DEVELOPMENTS ..................................... 6

U.S. ECONOMIC TRENDS .......................................................................................................................................6 INTERNATIONAL ECONOMIC TRENDS..................................................................................................................9 ECONOMIC DEVELOPMENTS IN SELECTED MAJOR TRADING PARTNERS...................................................... 15 SECTION 2: INTENSIFIED EVALUATION OF MAJOR TRADING PARTNERS .......................26 KEY CRITERIA ..................................................................................................................................................... 26 SUMMARY OF FINDINGS ..................................................................................................................................... 28 ANNEX I: REBALANCING THE GLOBAL ECONOMY ? PROGRESS REPORT.........................30 ANNEX II: GLOBAL CAPITAL FLOWS ? RECENT TRENDS AND VOLATILITY ....................38 GLOSSARY OF KEY TERMS IN THE REPORT ...............................................................................44

This Report reviews developments in international economic and exchange rate policies and is submitted pursuant to the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. ? 5305, and Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, 19 U.S.C. ? 4421.1

1 The Treasury Department has consulted with the Board of Governors of the Federal Reserve System and International Monetary Fund (IMF) management and staff in preparing this Report.

Executive Summary

The global economy accelerated in 2017 to its fastest pace of growth since the post-crisis rebound in 2011. The broad-based strengthening of growth was led by the United States, where domestic demand growth averaged 3 percent over the last three quarters of the year, and by a synchronized expansion in Europe. The Administration's economic focus is on laying the foundation for sustained faster growth and higher real median incomes. The new tax reform package, along with ongoing regulatory initiatives, aims to raise investment, increase productivity, and facilitate small business formation and expansion. Reforms are being pursued in many advanced and emerging market economies, and cementing these reforms would help brighten the medium-term outlook for the global economy.

Notwithstanding the pick-up in global growth, the U.S. trade deficit widened in 2017, mainly because domestic demand growth in our major trading partners lagged domestic demand growth in the United States, trade and investment barriers persist in many economies, and several surplus economies continue to have currencies that are undervalued per estimates by the International Monetary Fund (IMF).

The Administration remains deeply concerned by the significant trade imbalances in the global economy, and is working actively across a broad range of areas to help ensure that trade expands in a way that is fair and reciprocal. The United States' bilateral trade deficits with China, Japan, Germany, and Mexico are at very high levels. Further, as discussed in more detail in Annex I, current account surpluses among several major trading partners over the last two decades have proven both large and persistent. The global adjustment process has not worked effectively to promote a symmetric adjustment toward smaller imbalances in a manner that sustains ? rather than inhibits ? global growth. Nor are there signs that currently point toward a narrowing of external imbalances.

Achieving stronger and more balanced global growth will require that domestic demand, including consumption and investment, become the sustained engine for economic expansion in key economies that have maintained large and persistent external surpluses. This could be supported by these economies putting in place more efficient tax systems with low rates and broad bases, regulatory frameworks that support domestic investment, and sound monetary policies. The International Monetary and Financial Committee (IMFC) last fall concluded that strong fundamentals, sound policies, and a resilient international monetary system are essential to the stability of exchange rates, contributing to strong and sustainable growth and investment. In March, all G-20 members similarly endorsed this objective.

Securing faster global growth also requires that all economies durably avoid macroeconomic, foreign exchange, and trade policies that facilitate unfair competitive advantage. This Report, by monitoring where unfair currency practices may be emerging and encouraging policies and reforms to address large external surpluses, represents an important component of the Administration's strategy for securing a stronger America and a more robust and fair global economy.

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Lastly, this Report contains an annex that surveys the composition and volatility of global capital flows over the last few years. Large net capital flows have been the counterpart of substantial current account imbalances across the global economy over the last few years, or in China's case large net capital outflows were the counterpart to significant reserve sales. Notwithstanding the large nominal value of these capital flows, the annex shows that the volatility of flows to emerging markets is in line with historical levels when the flows are scaled to economic activity.

Treasury Assessments of Major Trading Partners

Treasury has established thresholds for the three criteria specified in the Trade Facilitation and Trade Enforcement Act of 2015 (the "2015 Act") that determine whether enhanced analysis is necessary: (1) a significant bilateral trade surplus with the United States is one that is at least $20 billion;2 (2) a material current account surplus is one that is at least 3 percent of gross domestic product (GDP); and (3) persistent, one-sided intervention occurs when net purchases of foreign currency are conducted repeatedly and total at least 2 percent of an economy's GDP over a 12-month period.3 In 2017, the $20 billion bilateral trade surplus threshold captured almost 80 percent of the value of all trade surpluses with the United States, while the 3 percent current account threshold captured more than threefourths of the nominal value of global current account surpluses.

Pursuant to the 2015 Act, Treasury has found in this Report that no major trading partner met all three criteria during the four quarters ending December 2017.

Similarly, based on the analysis in this Report, Treasury also concludes that no major trading partner of the United States met the standards identified in Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (the "1988 Act") for currency manipulation in the second half of 2017.

Because the standards and criteria in the 1988 Act and the 2015 Act are distinct, it is possible that an economy could be found to meet the standards identified in one of the Acts without being found to have met the standards identified in the other. In particular, a finding that an economy met the standards in the 1988 Act of manipulating its currency would require Treasury to examine a wider array of additional facts such as foreign exchange reserve coverage, capital controls, monetary policy, or inflation developments.

2 Given data limitations, Treasury focuses in this Report on trade in goods, not including services. The United States has a surplus in services trade with many economies in this report, including Canada, China, Japan, Korea, Mexico, Switzerland, and the United Kingdom. Taking into account services trade would reduce the bilateral trade surplus of these economies with the United States. 3 In assessing the persistence of intervention, Treasury will consider an economy that is judged to have purchased foreign exchange on net for 8 of the 12 months to have met the threshold. These quantitative thresholds for the scale and persistence of intervention are considered sufficient on their own to meet the criterion. Other patterns of intervention, with lesser amounts or less frequent interventions, might also meet the criterion depending on the circumstances of the intervention.

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Treasury has established a Monitoring List of major trading partners that merit close attention to their currency practices and macroeconomic policies. An economy meeting two of the three criteria in the 2015 Act is placed on the Monitoring List. Once on the Monitoring List, an economy will remain there for at least two consecutive Reports to help ensure that any improvement in performance versus the criteria is durable and is not due to temporary factors. As a further measure, this Administration will add and retain on the Monitoring List any major trading partner that accounts for a large and disproportionate share of the overall U.S. trade deficit even if that economy has not met two of the three criteria from the 2015 Act. In this Report, the Monitoring List comprises China, Japan, Korea, Germany, Switzerland, and India, the latter being added to the Monitoring List in this Report.

With regard to the six economies on the Monitoring List:

? China has an extremely large and persistent bilateral trade surplus with the United States, by far the largest among any of the United States' major trading partners, with the goods trade surplus standing at $375 billion over the four quarters through December 2017, an increase of $28 billion over 2016. Over 2017, the Chinese currency generally moved against the dollar in a direction that should, all else equal, help reduce China's trade surplus with the United States; however, on a broad, trade-weighted basis, the renminbi was broadly unchanged on net over 2017. Moreover, the increasingly non-market direction of China's economic development poses growing risks to its major trading partners and the long-term global growth outlook. China should advance macroeconomic reforms that support greater household consumption growth and help rebalance the economy away from investment. Treasury also places significant importance on China adhering to its G-20 commitments to refrain from engaging in competitive devaluation and to not target China's exchange rate for competitive purposes; and on greater transparency of China's exchange rate and reserve management operations and goals.

? Japan's goods trade surplus with the United States did not diminish in 2017, and stood at a still-large $69 billion over the four quarters through December 2017. Japan's current account surplus, meanwhile, grew over this period to 4 percent of GDP, its highest level since 2010. Japanese officials have publicly voiced concern over the appreciation of the yen this year, but Japan has not intervened in the foreign exchange market in over six years. Treasury's expectation is that in large, freely-traded exchange markets, intervention should be reserved only for very exceptional circumstances and with appropriate prior consultations. Japan should take advantage of the current window of steady growth to enact critical structural reforms that can support sustained faster expansion of domestic activity, create a more sustainable path for long-term growth, and help reduce Japan's public debt burden and trade imbalances.

? Korea maintains large external imbalances, with a current account surplus standing at 5.1 percent of GDP in 2017, its sixth straight year over 3 percent of GDP. Korea's goods trade surplus with the United States registered $23 billion in 2017, contracting nearly

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